Definition
Open-ended mutual funds are investment vehicles that consistently accept capital from investors and can issue an unlimited number of shares. They also buy back shares when investors wish to sell. In contrast, closed-ended mutual funds issue a fixed number of shares in an initial public offering and do not issue new shares or redeem existing shares; investors buy and sell these shares on the market.
Key Takeaways
- Open Ended Mutual Funds are investment vehicles where units are continuously issued and bought back by the fund. The price of these units is determined by the Net Asset Value (NAV) which fluctuates according to market movements. In contrast, Closed Ended Mutual Funds issue a fixed number of units during an Initial Public Offering (IPO), similar to how companies issue shares
- Investors in Open Ended Mutual Funds can buy or sell units at any time directly from the fund, which offers a high level of liquidity. On the other hand, investors in Closed Ended Mutual Funds can only buy units during the fund’s IPO and sell them on the stock exchange to other investors, which may offer lower liquidity if there is low demand for the units.
- While the performance of Open Ended Mutual Funds heavily relies on fund managers’ decision-making, Closed Ended Mutual Funds often allow for longer term investment strategies as they are not obligated to redeem units on demand, which can impact their potential returns and risks.
Importance
Understanding the distinction between Open Ended and Closed Ended Mutual Funds is significant in finance as it directly impacts an investor’s strategy, liquidity, and potential returns. Open Ended Funds allow investors to buy and sell units at any time, making them highly liquid, flexible, and typically priced at their net asset value (NAV). They are not traded in the open market and are unlimited in terms of the number of shares that can be issued.
In contrast, Closed Ended Funds have a fixed number of shares and are traded on the stock exchange, possibly at a premium or a discount to NAV. Their value is determined by market forces of supply and demand.
Essentially, these features offer different opportunities and risks, making the distinction vital for the investor’s portfolio strategy.
Explanation
Open-Ended Mutual Funds are investment vehicles created for the purpose of pooling resources from various investors to collectively invest in a diverse portfolio of securities. The key purpose of these funds is to provide investors with an opportunity to invest in a broad market segment without the need to manage each individual security. Open-ended mutual funds issue and redeem shares at their net asset value (NAV) at the end of each trading day directly with investors.
This means that the number of outstanding shares (or units) of an open-ended mutual fund can change daily and so does the fund’s market capitalization. On the other hand, Closed-Ended Mutual Funds also gather pooled funds, but they issue a specific number of shares, which are not redeemable from the fund itself. After the initial public offering, shares of closed-end funds are sold on the open market through a stock exchange, just like a stock or an ETF.
The purpose here is to provide a fixed pool of resources for fund managers, which they believe can offer superior returns to investors. Unlike open-ended funds, the number of shares or units of a closed-end fund remains constant; this allows the fund to take a longer-term strategic view on investments. The shares of closed-end funds often trade at a premium or discount to its NAV based on supply and demand factors.
Examples of Open Ended vs Closed Ended Mutual Funds
Vanguard 500 Index Fund (VFIAX): This is an example of an open-ended mutual fund. It’s continuously open for investors to both buy and sell their shares back to the fund. The fund’s assets under management can thus increase or decrease on a daily basis based on the net amount of investors’ buys or sells.
Eaton Vance National Municipal Opportunities Trust (EOT): This is an example of a closed-ended mutual fund. Unlike an open-ended fund, it has a fixed number of shares that are traded between investors on the open market, similar to stocks. Its share price is therefore determined by supply and demand in the market and can fluctuate above or below net asset value (NAV).
T. Rowe Price Equity Income Fund (PRFDX): This is another example of an open-ended mutual fund. It is always willing to issue new shares to investors and will buy them back when the investors wish to sell. This continuous creation and redemption of shares allow open-ended funds like PRFDX to better manage the flow of capital.
FAQs: Open Ended vs Closed Ended Mutual Funds
What are Open Ended Mutual Funds?
Open Ended Mutual Funds are a type of mutual funds that continuously offer new shares to investors and buy back shares when investors wish to sell. The price at which the shares are traded is determined by the net assets value (NAV) which is calculated at the end of each trading day.
What are Closed Ended Mutual Funds?
Closed Ended Mutual Funds are a type of mutual funds which have a fixed number of shares and these shares are traded among investors in the stock exchange. The price of the shares is determined by the market, based on supply and demand, which may be above or below the net asset value (NAV) of the fund.
What are the key differences between Open Ended and Closed Ended Mutual Funds?
The key differences between Open Ended and Closed Ended Mutual Funds are that Open Ended Mutual Funds continuously offer and buy back new shares from investors while Closed Ended Mutual Funds have a fixed number of shares which do not change. Therefore, Open Ended Mutual Funds do not trade on a stock exchange whereas Closed Ended Mutual Funds do.
Which type of Mutual Funds is better: Open Ended or Closed Ended?
There’s no definitive answer to this question as it depends on the investor’s needs and preferences. Open Ended Mutual Funds provide greater flexibility as you can buy and sell units at any time. On the other hand, Closed Ended Mutual Funds can be beneficial if they are trading at a discount to their NAV, providing an opportunity for higher returns. However, they offer less liquidity as they trade on a stock exchange.
Related Entrepreneurship Terms
- Net Asset Value (NAV)
- Redemption
- Fund Management
- Liquidity
- Investment Portfolio
Sources for More Information
- Investopedia: A comprehensive website that provides information on various investment and finance terms, including mutual funds.
- Morningstar: A leading provider of independent investment research that offers detailed insights into mutual funds.
- Moneycontrol: One of India’s leading finance websites, with extensive articles and resources on mutual funds.
- NerdWallet: A personal finance company that provides advice on investing and information on different types of mutual funds.
